ChiNext's Drama

ChiNext, China's growth enterprise board, needs more regulatory efforts to spur growth and become an effective source of financing for startup businesses 
 
AN AUSPICIOUS TAKE-OFF: Representatives from the 28 listed companies celebrate their IPOs in Shenzhen on October 30 (MA PING)

The ChiNext, China's NASDAQ-style stock market that has been in the making for the past decade, finally opened to prospective traders on October 30 on the Shenzhen Stock Exchange.

Enthusiastic investors rushed to join the financial party, prompting an explosion in share prices. All 28 listed firms closed with a significant run-up of at least 76 percent on their first day of trading.

So overwhelming was the buying rush that regulators temporarily suspended share trading of all 28 newly listed companies at different points throughout the opening day. Under rules created to rein in speculation on the first trading day, if a stock fluctuates beyond 20 percent from its opening price, it will be suspended from trading for 30 minutes.

The initial stock euphoria vanished as abruptly as it arrived, when second day trades saw 20 of the 28 firms dive by a daily limit of 10 percent as investors scrambled to sell off their investments on worries about valuation over-extension.

By November 13, a total of 14 stocks had slipped below their October 30 opening prices, a financial fiasco that was believed to have incurred painful paper losses for numerous investors that jumped in on ChiNext's opening day.

According to data from the Shenzhen Stock Exchange, on November 13, the market value of ChiNext was 127 billion yuan ($18.6 billion), 12.9 billion yuan ($1.9 billion) less than on October 30.

Given the dips and dives of the market so far, a mood of pessimism appears to be taking hold as worried investors start asking themselves the same question: Will the ChiNext follow in the footsteps of the bearish Hong Kong Growth Enterprise Market? And can ChiNext really become the second NASDAQ?

Funding the future

The China Securities Regulatory Commission said the new market was aimed at funding technology- and innovation-driven startup companies, in line with the country's economic restructuring to rely less on labor-intensive manufacturing. Before ChiNext opened its trade floor, the 28 companies had raised a combined 15.5 billion yuan ($2.27 billion) from their initial public offerings (IPO), far more than they had expected.

By the end of 2008, the number of China's registered small and medium-sized enterprises (SMEs) had exceeded 9.7 million, contributing 60 percent of the country's GDP, 50 percent of taxation, 66 percent of patents and 80 percent of job creations, according to data from the China Association of Small and Medium-Sized Enterprises (CASM).

However, many SMEs are struggling to survive. Among the many bottlenecks that choked their growth, the most devastating has been a lack of financing. In China, the SMEs rely on banks for 98 percent of their funding, but since most of them are startup businesses they have little access to bank loans.
 
STABILITY FIRST: Analysts believe health and stability are the most important factors for the development of ChiNext (LI JIAN)

The financial crisis only deepened their wounds. By handing out generous tax breaks and subsidies, policymakers tried to stanch the SMEs' pains, but the difficulty of attaining financing remains a sincere problem to the enterprises' growth and prosperity.

CASM Chairman Li Zibin told Beijing Review that an important alternative source of financing for the SMEs is the capital markets.

ChiNext, for instance, could become an effective channel for them to float their shares and seek financing, said Li.

In addition, it provides an exit for private equity (PE) investors, a long-anticipated boon to lure more PE investments to fuel growth of small firms, he added.

Analysts believe ChiNext, with a relatively low requirement for listing and some system innovations, is a suitable platform for SMEs to go public. Listing on the NASDAQ will no longer be the first choice for many smaller Chinese firms that are seeking direct financing, they said.

Opportunities and risks

The volatile new market means both opportunities and risks, not only for stock investors, but also for the listed enterprises.

Wen Yuechun, Director of the Zhejiang Merchants Securities Research Institute, said the new market can ease the financial woes of the smaller firms and strengthen their ability to press ahead with technological innovations.

For example, many of the firms listed on the SME board on the Shenzhen Stock Exchange have shown significant improvements in market shares and profitability, said Wen.

As a result, ChiNext is likely to serve as a catalyst for startup businesses to take off and push forward technological advances in their respective industries, he said.

Wen added that another benefit of ChiNext is that it provides an alternative for cash-stressed Chinese SMEs that do not have the necessary funds to be listed overseas.

A number of innovation-driven companies, including Sina.com, Baidu and Alibaba, have floated their shares overseas, a move that brought heavy costs and legal risks, he said.

But the market is not without uncertainties, and it remains to be seen whether ChiNext can maintain a healthy growth given the setbacks of Germany's Neuer Market and the Hong Kong Growth Enterprise Market, he said.

In addition, small firms listed on the growth enterprises board will be more vulnerable to hostile acquisitions from bigger rivals and may lose control of corporate management, said Wen.

Due to the relatively small market value, their shares can easily be manipulated by speculators. The PE and VC (venture capital) investors may as well speculate on the fickle new market, instead of investing in startup businesses, added Wen.

A bright prospect

Zuo Xiaolei, chief economist with the China Galaxy Securities Co. Ltd., said she hopes ChiNext can play an active role in stimulating innovation among the startup businesses.

"There is sill room for the market to improve its regulation system so as to create a better investment environment," said Zuo.

The IPO pricing inquiry system with a few large brokerage houses may inadvertently allow for rampant speculation, she said.

Zuo suggested that regulators could take into consideration online inquiries and share issuance systems like those adopted by Google Inc., which was fairer and more reasonable than the inquiry system.

Aside from these steps, measures need to be taken to improve the information disclosure system of the new market, Zuo said, adding that research reports should not rate shares of the ChiNext-listed companies and should also require a signature of approval.

Apart from the upper and lower limit of 10 percent, more rules could be created to rein in speculation on the market, such as temporary suspension of trading, said Zuo.

In the 1970s, the United States established the NASDAQ Stock Market, which provided a strong impetus to the prosperity of Silicon Valley and buoyed economic growth, said Zuo. Similarly, ChiNext will have far-reaching implications for the Chinese economy, she added.

More efforts, however, are still needed to perfect the market's regulatory system and pave the way for its healthy growth before a true comparison of ChiNext can be made with its American counterpart market, said Zuo.

Milestones for the ChiNext

In October 2003, the Second Plenary Session of the 16th Central Committee of the Communist Party of China passed a decision to push for the construction of venture investments and a growth enterprise market.

On January 31, 2004, the State Council issued Guidelines for Promoting the Reform, Opening up and Steady Growth of the Capital Market, stating that the country would advance the construction of the new market.

In August 2007, the State Council approved a scheme guiding the establishment of a multi-faceted capital market system focusing on growth enterprises.

On March 5, 2008, Chinese Premier Wen Jiabao ordered the establishment of the market.

On March 31, 2009, CSRC officially released its rules guiding the initial public offering on ChiNext, effective from May 1.

On July 15, 2009, investors started opening ChiNext trade accounts.

On July 26, 2009, CSRC officially accepted IPO applications from companies.

On August 14, 2009, the first review committee of ChiNext was established.

On September 17, 2009, the CSRC convened the review committee of ChiNext for the first time.

On October 23, 2009, the inauguration ceremony was held to mark the launch of ChiNext.

On October 30, 2009, ChiNext officially opened on the Shenzhen Stock Exchange.